Chapter 3, Exercise 5

Lists of pronouncements: On May 19, 2004, the International Accounting Standards Board (IASB) published a

single volume of its official pronouncements. These pronouncements would be applicable from 1 January, 2005.

The International Financial Reporting Standards (IFRS) Bound Volume 2004 provides the complete

consolidated text of the latest version of the IFRS. International Accounting Standards (IASs) and

interpretations and supporting documents published by IASB.

IFRS 1 First-Time Adoption of International Financial Reporting Standards

IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

Chapter 4, Exercises 1 and 4

Exercise 1. A company incurred the following costs related to the production of inventory in the current year:

The cost of materials included abnormal waste of $10,000. What is the cost of inventory in the current year?

a. $190,000.
b. $205,000.

c. $215,000.

d. $217,000. (Doupnik 158)

Answer B ($100,000 - $10,000) + $60,000 + $30,000 + $25,000 = $205,000.

Exercise 4. On January 1, Year 1, an entity acquires a new machine with an estimated useful life of 20 years for

$100,000. The machine has an electrical motor that must be replaced every five years at an estimated cost of

$20,000. Continued operation of the machine requires an inspection every four years after purchase; the

inspection cost is $10,000. The company uses the straight-line method of depreciation. What is the depreciation

expense for Year 1?

a. $5,000.

b. $5,500.

c. $8,000.

d. $10,000. (Doupnik 159)

D is the answer. Total $100,000

Motor = $20,000/5 years = $4,000

 Inspection $ 10,000 / 4 years = $2,500

Machine $70,000 / 20 years = $3,500

TOTAL = $10,000

Chapter 5, Case 5-1 (S.A. Harrington Co.)

Case 51: S. A. Harrington Company

S.A. Harrington Company is a U.S.-based company that prepares its consolidated financial statements in

accordance with U.S. GAAP. The company reported income in 2011 of $5,000,000 and stockholders equity

at December 31, 2011, of $40,000,000.

The CFO of S. A. Harrington has learned that the U.S. Securities and Exchange Commission is considering

requiring U.S. companies to use IFRS in preparing consolidated financial statements. The company wishes

to determine the impact that a switch to IFRS would have on its financial statements and has engaged you to

prepare a reconciliation of income and stockholders equity from U.S. GAAP to IFRS. You have identified

the following five areas in which S. A. Harringtons accounting principles based on U.S. GAAP differ from

IFRS.

1. Restructuring

2. Pension plan

3. Stock options

4. Revenue recognition

5. Bonds payable

The CFO provides the following information with respect to each of these accounting differences.

Restructuring Provision
The company publicly announced a restructuring plan in 2011 that created a valid expectation on the part

of the employees to be terminated that the company will carry out the restructuring. The company

estimated that the restructuring would cost $300,000. No legal obligation to restructure exists as of

December 31, 2011.

Pension Plan

In 2009, the company amended its pension plan, creating a past service cost of $60,000. Half of the past

service cost was attributable to already vested employees who had an average remaining service life of 15

years, and half of the past service cost was attributable to nonvested employees who, on average, had two

more years until vesting. The company has no retired employees.

Stock Options

Stock options were granted to key officers on January 1, 2011. The grant date fair value per option was

$10, and a total of 9,000 options were granted. The options vest in equal installments over three years:

one-third vest in 2010, one-third in 2011, and one-third in 2012. The company uses a straight-line method

to recognize compensation expense related to stock options.

Revenue Recognition

The company entered into a contract in 2011 to provide engineering services to a long-term customer over

a 12-month period. The fixed price is $250,000, and the company estimates with a high degree of

reliability that the project is 30 percent complete at the end of 2011.

Bonds Payable

On January 1, 2010, the company issued $10,000,000 of 5 percent bonds at par value that mature in five

years on December 31, 2014. Costs incurred in issuing the bonds were $500,000. Interest is paid on the

bonds annually.
 Required

Prepare a reconciliation schedule to reconcile 2011 net income and December 31, 2011 stockholders

equity from a U.S. GAAP basis to IFRS. Ignore income taxes. Prepare a note to explain each adjustment

made in the reconciliation schedule.

1
The IASC-US Comparison Project: A Report on the Similarities and Differences between IASC

Standards and US GAAP: 2nd Edition, published by the FASB, 1999.

2
Ernst & Young, The Evolution of IAS 39 In Europe, Eye on IFRS Newsletter, November 2004, pp. 1

4. (Doupnik 231)

2011
$5,000,0

Income under U.S. GAAP 00

Adjustments:
Restructuring charge (300,000)
Additional past service cost (6,000)
Compensation cost (stock options) 5,000
Recognition of service revenue 75,000
Interest expense on bonds payable 6194
Income under IFRS 4,780,194

2011
$40,000,

Stockholders equity under U.S. GAAP 000

Adjustments:
Restructuring charge (300,000)
Accumulated additional past service cost (42,000)
Accumulated compensation cost (stock options) (20,000)
Recognition of service revenue 75,000
Interest expense on bonds payable 17,859
 Stockholders equity under IFRS 39,730,859

Restructuring. Under U.S. GAAP, the restructuring is not recognized in 2011 because a legal obligation does not

yet exist.

Under IAS 37, a restructuring provision and offsetting expense in the amount of $300,000 would be recognized

in 2011 because a constructive obligation does exist.

IFRS income would be $300,000 less that U.S. GAAP income in 2011, and stockholders equity at year-end

2011 under IFRS would be less than under U.S. GAAP by the same amount.

Pension Plan. Under U.S. GAAP, the prior service cost is amortized over the remaining service life of the

employees. Expense recognized in 2011 is $4,000 [$60,000 / 15 years]. The cumulative expense recognized

since the plan was changed in 2010 is $8,000 [$4,000 x 2 years]

Under IAS 19, the prior service cost attributable to the vested employees would have been expensed in 2010

$30,000 [50% x $60,000]. The prior service cost attributable to non-vested employees would be expensed over

the three remaining years until vesting. Expense recognized in 2011 would be $10,000 [$30,000 / 3 years]. The

cumulative expense recognized since the plan was changed is $50,000 [$30,000 + ($10,000 x 2 years).

IFRS income in 2011 would be $6,000 less than U.S. GAAP income, and stockholders equity at year-end 2011

under IFRS would be $42,000 less than under U.S. GAAP.

Stock Options. The total compensation cost related to the stock options is $90,000. Under U.S. GAAP,

compensation expense would be recognized at the rate of $30,000 per year, for a total cumulative expense at

year-end 2011 of $60,000.

Under IFRS, compensation expense would be recognized as follows:

Installment Compensation

Cost per

Installment Compensation Expense 2010 Compensation Expense 2011 Compensation Expense 2011 1 $30,000

$30,000 $ $ 2 $30,000 15,000 15,000 3 $30,000 10,000 10,000 10,000 $90,000 $55,000 $25,000 $10,000
Compensation expense in 2011 would be $25,000 and cumulative compensation expense would be $80,000.

IFRS income would be $5,000 larger than U.S. GAAP income in 2011, but IFRS stockholders equity would be

$20,000 smaller.

Revenue Recognition. No revenue would be recognized on this service contract under U.S. GAAP because the

services have not yet been completed.

Under IFRS, the company would use the stage of completion method to recognize service revenue of $75,000

[$250,000 x 30%] in 2011.

In 2011, IFRS income would be $75,000 larger than under U.S. GAAP; at December 31, 2011, IFRS

stockholders equity also will be $75,000 larger than under U.S. GAAP.

Bonds Payable. Under U.S. GAAP, $600,000 would be recognized as expense in 2010 and 2011 related to the

bonds payable: $500,000 interest expense [$10,000,000 x 5%] and $100,000 bond issuance expense [$500,000 /

5 years]. The total reduction in retained earnings as of December 31, 2011 would be $1,200,000.

Under IFRS, the bond issuance costs reduce the carrying amount of the bonds to $9,500,000, and the effective

interest rate is determined to be 6.193% [$9,500,000 cash inflow on January 1, 2010; $500,000 cash outflow on

December 31, 2010 2014; and $10,000,000 cash outflow on December 31, 2014]. Interest expense in 2010 is

$588,335 [$9,500,000 x 6.193%]. Interest expense in 2011 is $593,806 [($9,500,000 + ($588,335 - $500,000)) x

6.193%]. The total reduction in retained earnings as of December 31, 2011 would be $1,182,141. In 2011, IFRS

income would be $6,194 [$600,000 - $593,806] larger than U.S. GAAP income. Stockholders equity at

December 31, 2011 is $17,859 [$1,200,000 - $1,182,141] larger under IFRS than U.S. GAAP. Note: The

adjustments related to interest expense on bonds payable will differ depending on rounding of the effective

interest rate. For example, if the effective interest rate is rounded to 6.2%, interest expense under IFRS would

be $589,000 [$9,500,000 x 6.2%] in 2010 and $594,518 [($9,500,000 + ($589,000 - $500,000)) x 6.2%] in

2011. In 2011, IFRS income would be $5,482 [$600,000 - $594,518] larger than U.S. GAAP income.

Stockholders equity at December 31, 2011 would be $16,482 [$1,200,000 - $1,183,518] larger under IFRS than

U.S. GAAP